US bonds: get in on ground (7.5%) floor

The decline in interest rates has raised another sort of interest: interest in United States savings bonds and other certificates from the US Treasury. Sure, their rates aren't what they used to be, but you have to put your money someplace, and those who want part of their cash to enjoy the the safety of direct US obligations may find that bonds, bills, and notes are a comforting choice.

For the past few years, one of the attractions of savings bonds has been a 7.5 percent interest rate ``floor.'' As interest rates started to slide, people buying savings bonds knew that no matter how low overall rates got, they would never earn less than 7.5 percent as long as they held the bonds at least five years. They might also earn more, since the rate is adjusted to keep it in line with other market rates.

That 7.5 percent floor may be sagging soon. Several months ago, the Treasury announced that with interest rates so low, 7.5 percent might be too generous, and it was considering a lower floor, perhaps 6.5 percent. So far the bottom rate -- which is also the current rate -- has not been reduced.

``We're safe for September,'' says Treasury spokesman Steven Meyerhardt. Any change in the rate, he explained, would have to apply to bonds sold in the following month.

So while we don't know if the Treasury is going to lower the rate for October, or maybe for November, or perhaps December, people considering savings bonds might want to buy them in September. This way, the bond will never earn less than 7.5 percent and it could earn more, if interest rates rose again before the bonds mature.

The rate you are paid when a bond is cashed in is based on a combination of all the rates that were in effect since it was purchased. This rate affects how long it takes for the bond to mature. Savings bonds are a form of zero-coupon bond and are purchased for half their face value. At current rates, it takes about nine or 10 years for a bond to reach this level; if rates go down, maturity will take longer.

In addition to what is currently a very good interest rate, savings bonds have several other features that make them worth considering. With everybody thinking about tax reform, it's good to know that interest on savings bonds is free of federal taxes until they are cashed in, and that they're always free of state and local taxes.

You can defer the tax bite further by converting Series EE bonds into the HH variety. With EE bonds you can receive interest periodically or in a lump sum at maturity, or you can roll the interest and principal into an HH bond. With HH bonds, you must take an interest payment every six months, but for retired people, who use these bonds most often, this is not that great a problem, since they're probably in a lower bracket to begin with.

Savings bonds also make handy ways to transfer assets to your heirs. If a husband and wife are joint beneficiaries, the bonds pass to the surviving spouse automatically. No taxes have to be paid; no transfer of ownership has to be recorded; no reissuing has to be done; and they don't have to be probated. The survivor just hangs onto the bonds until they mature and pays whatever taxes are due at that time.

You can also make the taxless transfer with another heir by putting his or her name on the bond as beneficiary. When the first owner dies, the beneficiary can either cash in the bond or hold it to maturity.

``It's one of the simplest things to transfer,'' Mr. Meyerhardt says.

Buying savings bonds is also easy: Most banks and savings-and-loans have them.

Buying other US Treasury securities is somewhat more complicated. The easy way is to pay a bank or broker a service fee and have it get the securities for you. But that fee can be as high as $50, so you might want to buy them yourself.

You can buy ``treasuries'' either by mail or in person at the Federal Reserve bank in your district. There are 12 districts, with banks in Boston; New York; Philadelphia; Cleveland; Richmond, Va.; Atlanta; Chicago; St. Louis; Minneapolis; Kansas City, Mo.; Dallas; and San Francisco. You can get the phone number from directory assistance and another phone call will get the address.

If you go in person you fill out a form and present payment, which can be cash, a certified personal check made out to the Federal Reserve bank or the US Treasury, or matured treasury notes or bonds. You can make competitive or noncompetitive bids.

Most individuals enter a noncompetitive bid, which keeps them from being shut out of the auction or entering a bid that is too low. This bid gives people the weighted average yield of the competitive bids accepted.

If you want to enter your bid by mail, send a letter to the Federal Reserve bank in your area, and include your name and address; your social security or taxpayer identification number; the size, type, and maturity of the security you want; whether the bid in noncompetitive; in whose name the securities will be registered; the address for delivery of notes and bonds and their interest (for treasury bills, note whether you want the funds reinvested in new securities at maturity); your signature; and the payment.

Treasury bills have maturities of 13, 26, and 52 weeks and a minimum investment of $10,000; notes run from two to 10 years, and the minimums are $5,000 for notes maturing in less than four years and $1,000 for notes longer than four years; bonds mature after 10 years and have a $1,000 minimum.

If you have a question that would make a good subject for this column, please send it to Moneywise, The Christian Science Monitor, One Norway Street, Boston, Mass. 02115. No personal replies can be given by mail or phone.